Greece: Default is no soft option

The head of the European Central Bank once again said today that a Greek default "would not happen". Every G20 official - in or outside the eurozone - will tell you the same thing: with markets as fragile as they are, it is unthinkable that a sovereign government would be allowed to default. Investors and experts are thinking about it all the same.

As you'd expect, there's no rule book for countries seeking to default on their debt. It's not something the international system likes to encourage. But it's not as if it has never happened. There have been 40 defaults by sovereign governments in the past 20 years alone, and more than 70 since 1980.

Many of those governments were able to borrow again quite soon after - sometimes in a matter of months. But only when they were able to do a deal with all - or nearly all - the bond-holders on how much of the debt would get repaid - and over how long.

Russia took less than two years to restructure its foreign debt after declaring a moratorium in August 1998. Creditors lost about half of the value of the principal. A similar deal was done over the same period for Ukraine and its debt. But as we know, Argentina in January 2002 was different: messier and much more drawn-out. Offered only 30 cents on the dollar, some bond-holders are still holding out, eight years later. Only now is the country able to talk about borrowing again on international capital markets.

Research by IMF economists (The Costs of Sovereign Default, Working Paper October 2008) suggests the long-term cost of default for countries can be quite low: after a few years, governments don't even pay much of a premium on world markets. But the short-term cost to the economy can be huge. That would certainly apply to Greece today.

Imagine the Greek government stopped paying interest on its debt tomorrow. It would still have a primary deficit - excluding interest payments - of more than 8% of national income, and it might not have anyone to borrow that money from. That could mean more austerity, not less, especially if the country remained in the euro.

There would also be the collapse of the domestic banking system to consider, Greek banks being the largest holders of Greek sovereign debt. And that's before you get even to the costs of contagion for other countries, as investors wondered who would be next.

Many investors now think a Greek default - or debt restructuring - is inevitable at some point. They may be right. But it's no soft option. There are good reasons why European officials will keep saying it is unthinkable for as long as they possibly can.

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On Friday, the German Bundestag Backed the Greek Bailout Extension. Ahead of the vote, many commented that Greece collapsed. It's not all that simple as I have explained.The likely explanation for the alleged collapse of Syriza is Greece did not have a primary account surplus. Had it left now, it would have been forced off the euro, violating a campaign promise of Syriza.

Investors who plowed into Greek assets ahead of Mario Draghi's QE €60 billion a month bond-buying spree figuring the ECB could paper over this mess have been pounded almost nonstop recently.Today alone, Greek bank shares plunged 22-29%, and yield on the 3-year Greek treasury hit 16.97%.Worst Day in History for Greek Bank SharesBloomberg reports Greek Markets Hammered as Fears Grow Over New Government.

Argentina had one card to play left in its battle against hedge fund creditors, and it just lost. Judge Thomas Griesa said that a New York Court will not grant Argentina a stay on payment to bondholders as it attempts to negotiate the payment of over $1.3 billion worth of bonds owed to a group of hedge fund creditors referred to collectively as NML.

With Argentina suddenly no longer able to kick the can any longer in its decade long fight with holdout investors, and warning that unless the covenants of the foreign law bonds are stripped in effect making them local-law bonds (and undergoing an event of default for CDS purposes), everyone is focusing on how soon until the sovereign default parade will again resume, following the Greek technical bankruptcy two years ago.

How long can secret ECB meetings stay secret? Allowing time to write a story, the answer is something like 3 days, if that. The Wall Street Journal today reports on a secret meeting that took place Monday evening regarding Greece finances.Please consider Greece Creditors, France, Germany Held Secret Meeting Monday.

Brussels responded with barely-contained fury Thursday to the IMF’s claim that it had sacrificed Greece to save the euro from debt crisis contagion.
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At long last the ISDA has agreed that Greece in in default, and that default constitutes a "credit event".
Bloomberg reports Greece Deal Triggers $3B in Default Swaps.
Greece’s use of collective action clauses forcing investors to take losses under the nation’s debt restructuring will trigger payouts on $3 billion of default insurance, the International Swaps & Derivatives Association said.